Friday, October 26, 2012

Lachmann on Liquidity Preference

I began reading this paper and at first remained quite disappointed, for Lachmann (on p. 302) about halfway through his discussion declares that his “attempt to establish a causal relationship between Uncertainty [sic] and liquidity-preference has so far turned out to be a complete failure.”

After this, the paper improves. If uncertainty is defined as the anxiety of the debtor whose debt is due on demand, then uncertainty, says Lachmann, can be the cause of liquidity preference (Lachmann 1937: 302).

Money has as a medium of exchange an indirect utility derived from the goods it can purchase (Lachmann 1937: 303).

Then the following interesting analysis occurs:

“In other respects Money yields direct satisfaction, e.g., in its function of a store of value. But we have already seen that in this respect it has almost as many substitutes as there are (non-perishable) goods, and that it is impossible to predict when it will be used as store of value and when something else. Sometimes the satisfaction derived from its possession will be even more ‘direct’. Moliere’s Harpagon, e.g., derives as much ‘direct satisfaction’ from the contemplation of his hoarded treasures as does the spectator from seeing him on the stage.” (Lachmann 1937: 303–304).

So here we see that the notion that money yields direct utility is not unknown in Austrian economics, and was proposed as early as 1937 by Lachmann.

Lachmann also notes how, in the world of business, demand for money for investment and other business activity essentially means demand for credit, and that many businesses can obtain that credit via negotiable debt instruments, and not high-powered money directly (Lachmann 1937: 306) – which anticipates endogenous money theory.

Lachmann concludes that uncertainty is the cause of liquidity preference (Lachmann 1937: 306).

Postscript
It is a pity that the final two pages of the article (Lachmann 1937: 307–308), where Lachmann discusses liquidity preference and the trade cycle, are disappointing, in that Lachmann’s proposal for dealing with increased liquidity preferences of banks during a recession/depression is to compel “immediate reconstruction [sc. of banks] after the outbreak of a crisis” and to “enforce the early closing of all banks” where reconstruction is not possible (Lachmann 1937: 308). While quick bank “reconstruction” is all well and good, it does not follow that insolvent banks must close (which, I assume, requires mass loss of the money of depositors?). The latter would just exacerbate the crisis.